The demand for operating reserves: key to price spikes and investment

Under regulation, operating-reserve policy and investment policy are completely separate. In a market, they are tightly linked through expectations. Currently, regulators and engineers intervene in markets to determine how much will be paid when operating reserves are in short supply. These prices largely determine the revenue stream that pays the capital costs of new peakers and pays an equal amount toward the capital costs of all other generators. In this way, operating-reserve and price-cap policies determine investment in generation and the equilibrium level of installed capacity. Typically, FERC determines a price limit, and engineers, by setting an operating-reserve requirement, determine the expected duration of price spikes. Currently, these policies are set without coordination and without analysis of the long-run consequences.